An Analysis of the Business Strategy of Diversification; Using Empirical Financial Data

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Table of Contents

ABSTRACT        3

INTRODUCTION        4

RESEARCH (Industries)        7

Media Networks        7

Soft Drinks        10

Personal Computers        12

Financial Services        15

Home Fixtures        18

Offshore Marine Services        22

CONCLUSION        25

FURTHER RESEARCH        26

REFERENCES        27


ABSTRACT:

This paper examines the business strategy of diversification.  Diversification of business lines was widely considered to be a prudent strategy throughout the 1980’s.  Diversification offered multiple revenue streams as well a degree of hedged risk management.  However, the practice of diversification largely fell out of favor beginning in the 1990’s.  Many companies began to devote full focus to their primary business line, while spinning off business lines that were considered to be unrelated to their core competency.  Focusing on the core competency products and/or services was thought to be a more efficient approach, with a higher return on the company’s resources.  The strategy of business diversification has largely been theoretical with little empirical evidence collected to measure its success or failure.

This paper compares the performance of heavily and lightly diversified companies across a wide spectrum of industries.  The purpose is to collect, measure and analyze the financial performance of these firms for their shareholders.  This exercise is not done to either totally validate or disqualify the strategy of business diversification.  It is recognized that individual situations between companies may vary widely and no single strategy may be a “best fit” for all.  Financial performance is affected by many external and internal stimuli apart from the decision to diversify.  Therefore, the purpose of this analysis is merely to look for trends between heavily and lightly diversified companies, which may warrant further study.  Further studies on this subject, could give Management tangible data to draw upon when making diversification decisions, rather than solely relying on theoretical assumptions or “gut” feelings.

Note:  This paper is written in accordance with the Academy of Management call for submissions under their Business Policy and Strategy (BPS) division.  The topics covered by this division includes, “strategy formulation and implementation” and well as “diversification and portfolio strategies”.


“Make winners out of every business in your company.  Don’t carry losers” – Jack Welsh

INTRODUCTION:

        The question of diversification is often a critical business strategy consideration for companies.  The authors of the book, Crafting and Executing Strategy, offer the following conditions for when a company becomes a candidate for diversification:

  1.  “Whenever a single business company encounters diminishing market opportunities and stagnating sales in its principle business.”
  2. “When it spots opportunities for expanding into industries whose technologies and products complement its present business.”
  3. “When it can leverage existing competencies and capabilities by expanding into businesses where these same resource strengths are key success factors and valuable competitive assets.”
  4. “When diversifying into closely related businesses opens new avenues for reducing costs.”
  5. “When it has a powerful and well known brand name that can be transferred to the products of another business and thereby used as a lever for driving up the sales and profits of such businesses.”

(Thompson, Strickland, & Gamble, 2008).

Even after the “prime” decision to diversify has been made, several more decisions remain to be considered.  For example:  Should the company either acquire an existing business; grow the business organically; or consider partnering with another entity?  To what extent should the company diversify (i.e., how many slices should be in the product/service “pie” offered by the company?  Should the company diversify into a closely related business or one that is unrelated?

One of the prime reasons why companies choose to be diversified is that it spreads risk and acts as a natural hedge.  If one product line falters, then the company may rely on another to pick up the slack, if it is in an unrelated area.  However, the goal of diversification should extend beyond risk management.  “Diversification must do more for a company than simply spread its business risk across various industries.  In principle, diversification cannot be considered a success unless it results in added shareholder value …” (Thompson et al., 2008)  Ultimately, any strategy adopted by Management, including that of diversification, as to pass this most basic test of adding shareholder value.  This paper seeks to examines the financial performance of companies in a wide range of industries, and compare those which are heavily diversified versus those that are not.

COMPANY SELECTION:

This paper compares two different companies within six different industries.  Therefore, a dozen companies were analyzed in all.  When choosing a diversified company to analyze I placed it the industry grouping in which the majority of its sales are currently generated (based on the most recent company annual report).  For example, although the Walt Disney Corporation profits from theme parks, movie production and licensing, most of its revenues are derived from its media networks.  Therefore, I bench marked Disney against another media company (CBS) and not against another theme park operator.  Those companies with a fairly wide source of revenue streams across multiple industries, products, and/or service lines I branded as “Diversified”.  In the paper I have displayed the relative business segment revenue for each of these companies.

Lightly diversified companies were given this distinction in relation to the more heavily diversified company selected.  These companies may have some level of diversification, but less so than that of the businesses used for comparison (i.e., the concept of diversification if all relative in this exercise).  I labeled these lightly diversified companies as “Core”, as they have chosen to focus a greater percentage of their resources on their main business (i.e., core competency).  Company selection was relatively random and I did not know the outcome of the company’s performance indicators in advance.

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FINANCIAL PEFORMANCE MEASUREMENTS:

I used several different metrics in measuring a company’s performance over a five year period, including:

  • STOCK PRICE GROWTH: Often considered the most fundamental indicator of shareholder performance.  This calculates the percentage growth of a common stock share over the period.
  • REVENUE GROWTH:  Revenue is the total sales (“top-line”) of the company.
  • GROSS MARGIN GROWTH:  Gross Margin subtracts the Cost of Goods Sold from Revenue.  When this sum is divided by total revenue the result is Gross Margin Percentage.  The cost of goods sold subtracts direct cost associated with producing the product but excludes ...

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